Pricing climate change

By Marius-Cristian Frunza
Weekly Briefs

July was the warmest month on the Earth in modern history. Climate change is more than a topic of political debate. The leading financial institutions integrate climate change in their long-term risk budgeting. Institutional investment portfolios will be rebalanced to reflect the foreseeable impacts of global warming. Is the stock market ready to price the climate change risk appropriately?

Global climate change has its roots in the enhanced greenhouse effect caused by human activity. Human activities, particularly the development of the industry over the last 200 years, have caused an increase in the emission and atmospheric concentration of certain gases, called ”greenhouse gases” - primarily carbon dioxide and methane.

Climate change is the term used to explain the changing weather patterns the earth is experiencing. Consensus scientific projections estimate that the average global temperature will rise by between 2°C and 5.8°C by 2100 if no serious measures are taken to reduce carbon-intense human processes. Moreover, state of the art climate modelling projects that even a small temperature rise will generate potentially damaging environmental events beyond the increase of the average global sea level. Heat waves, new diseases, reduced availability of drinking water,  extreme events such as cyclones and hurricanes will increase in frequency and severity.

Financial instruments aiming to price the climate change risk are scarce. Carbon emissions, catastrophic bonds and weather derivatives are amongst the few tools that incorporate the above-mentioned risks. Needless to say,  these instruments are, with a few exceptions, not accessible to retail investors.

Thus, the stock market will need to reshape itself and revalue its assets to integrate the impact of climate change. ESG investing is one of the avenues aiming to reach this goal. However, ESG is currently a nice feature to have rather than a fundamental tool to add value to investors. The big issue with climate-friendly investing is that the potential gain for investors is not clear. Most retail investors are reluctant to such strategies as they perceive it as a cost and not an opportunity to generate profit. At the end of the day, fuel is still the cheapest source of energy.

The rise of tech giants exhibiting hyper-inflated valuations compared to traditional industrial companies signals that some trends are changing. But is this sufficient?

Climate change is real. It is happening right now, it is the most urgent threat facing our entire species and we need to work collectively together and stop procrastinating. Leonardo Di Caprio, Actor & Environmentalist

Market overview

Since the beginning of the month, VIX, the main volatility index, has been on a descending path, nearing the lowest levels observed after the pandemic outbreak. The Dow Jones found support at 35,000, while Nasdaq conceded ground and ended the week below the 15,000 mark. In addition, the latest inflation numbers are less pessimistic than expected; the U.S. Bureau of Labor Statistics reported an increase in the consumer price index of  0.5% in July, compared to 0.9%  in June.

Focus:

Tesla

Electric vehicles represented 2.4% of total car sales in the United States in 2020. While the market share is still insignificant, the yearly growth is above 200%. Tesla, the world’s biggest car manufacturer in terms of market capitalisation, aims to beat the German car producers on their own ground. One of Musk’s wise ideas was to open a production plant near Berlin and produce American EVs in Europe, thereby targeting the European market, primarily dominated by German brands.

Traditional vehicle suppliers are scaling their production capacity sharply to address the growing EV market, thereby weakening Tesla’s position. Investors are backing the leading EV producer and penalising the manufacturers that commercialise ignition engines. Seemingly, the concerns about climate change make their place in portfolio allocation strategies.

Cryptocurrencies:

PSG tokens

Lionel Messi’s flash transfer from Barcelona FC to Paris Saint-Germain made the headlines of all sport news agencies. The Catalonian club is going through a tormented period and needs to get its finances right. Thus, they were forced to let go of the world's best football player.

But, the only club that was in shape to take over the enormous financial burden was the Qatar-backed Parisian club. PSG gratified Messi with a welcome package including an undisclosed number of  PSG fan tokens. Thus, the Argentinian star becomes the first prominent football player that accepts a cryptocurrency-based remuneration. Shortly after Messi arrived in the French capital, the price of PSG tokens doubled in several trading sessions. Nevertheless, the generated momentum did not last, and the token price suffered a significant correction. Messi’s contract in crypto is a game-changer in the world of professional sport.

Traditional streams of income are severely hindered by the pandemic and the slow death of broadcasting businesses. The tokenisation of sports finance seems the only viable avenue to sustain the huge flows of monies needed to keep the industry afloat.

Commodities:

Carbon emissions

Climate change seems to be more than ever a hot topic amid a very hot summer. But, curbing the global emissions curve will come with high costs. The carbon price on the EU’s emission trading scheme, the world's biggest carbon market, is near an all-time high. The market is buoyant since 2020, and the newcomers brought a strong momentum.  The European Commission is keen to take supplemental measures to tighten the supply of carbon allowances, thereby creating more bullish conditions. The big reform initiated by the Commission in 2018, which led to creating the market stability reserve, seems to show results. Nevertheless, the current pattern could push the carbon prices above 100 Euros.

Market outlook

The Dow Jones Index climbed in the last trading above the 35,500 mark. However, the perspective of non-transitory inflation and a new wave of Delta-variant related infections are putting investors in a risky spot.

As predicted, Bitcoin’s price soared above 47,000, which confirms the beginning of a new rally. Nevertheless, some technical corrections could be expected over the next few days.

General Disclaimer

The information and data published in this research were prepared by the market research department of Darqube Ltd. Publications and reports of our research department are provided for information purposes only. Market data and figures are indicative and Darqube Ltd does not trade any financial instrument or offer investment recommendations and decision of any type. The information and analysis contained in this report has been prepared from sources that our research department believes to be objective, transparent and robust.